Microsoft: A 'buy' after Justice shift?

Pro: it's a bargain; con: death of a thousand cuts

By

DeborahAdamson

REDMOND, Wash. (CBS.MW) -- Breaking up is hard to do. Now Microsoft doesn't have to go through it.

On Thursday, the U.S. Department of Justice said it won't be seeking a breakup of Microsoft
MSFT, -0.35%
nor will it pursue the resolution of an unresolved charge that the software giant broke antitrust law by tying its Internet Explorer browser to the Windows operating system. Instead, the government wants to put curbs on Microsoft's anti-competitive conduct. See full story.

Shares of Microsoft initially surged on the news, but it soon fell back. The stock was down 9 cents to $57.65 in recent trading. Shares didn't respond more positively because the decision not to break up Microsoft wasn't a big surprise, analysts said, given a Justice Department under the business-friendly Bush administration.

With a settlement seemingly on a faster track, is it safe for investors to get in the water again and buy the stock? Or should they wait until they know the extent of the government's penalties first? Perhaps they should put more weight on the PC market's woes than lawsuits?

Pro

"I'm telling people to buy Microsoft," Geurkink said. "This ruling is "absolutely ... good for Microsoft."

Asked why the stock hasn't reacted more positively to the news, he said the optimistic development has been overwhelmed by negative market sentiment and a concern about weakness in the tech sector.

But Geurkink said that once the tech downturn blows over, Microsoft will be one of the stronger companies to pull through in an environment of "diminished competition."

He believes Windows XP is a "great product, especially for consumers in the home plagued by stability issues of Windows" 95 and 98 versions. XP is "not a bridge for past products," he added. Rather, it provides "full-blown 32-bit computing."

In addition, the analyst said XP enables "zero configuration" for use in wireless local area networks -- which functionality Starbucks is slowly incorporating into its cafes.

Geurkink also thinks the company's Xbox game console is a "neat product" and "a whole new area for Microsoft to get into."

"The game console market is not about selling hardware. It's about selling software and games," the analyst observed.

Lastly, Geurkink was impressed with Microsoft's research brain trust, which just celebrated its 10th anniversary. He said it has labs all over the world, including Cambridge, Beijing, the San Francisco Bay area and of course, Microsoft's headquarters in Redmond, Wash.

"Microsoft has the heft, scale and cash to invest $5 billion (this year) in research and development," he added. "That's innovation."

With Microsoft at these price levels, "it looks like a bargain right now," said Geurkink, who has a two-year price target of $85 a share.

Con

Microsoft's fair value price is $66, Beaulieu said, based on Morningstar's discounted cash flow model. But the gap between the fair and current market price reflects investor uncertainty, he said.

Indeed, uncertainties about its legal penalties should give investors pause despite the drop to more attractive valuations, he said.

"The problem with the stock right now is it's very difficult to tell what kind of effect government penalties will have on revenues," he said. "It's timing. If a settlement is reached this year, we could figure in the penalty effect. But what if it's three to four years from now?"

While he doesn't think European regulators would pose much of a problem given the U.S. decision, he nevertheless believes the company could face the "death of a thousand cuts" -- lawsuits from individual companies basing their claims on the court's finding that Microsoft abused its monopoly position.

In addition, Microsoft is vulnerable to the woes of the PC market. This market generates more than half of the company's revenue. While the company is showing solid growth in sales of Windows 2000, Beaulieu said, a lot is riding on the coming Windows XP.

As for the Xbox, he said Microsoft might generate a lot of revenue from the game system initially but it might not be able to keep up with more seasoned companies in the business -- Nintendo's NTDOY GameCube or Sony's SNE PS2. Sega, which has been in the business for more than a decade, didn't succeed with Dreamcast.

Microsoft has a reputation of taking a few tries to get anything right and the console market is unforgiving, the analyst added.

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